FEDERAL COURT OF AUSTRALIA SPI PowerNet Pty Ltd v Commissioner of Taxation [2013] FCA 924 Citation: SPI PowerNet Pty Ltd v Commissioner of Taxation [2013] FCA 924 Parties: SPI POWERNET PTY LTD v COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA File numbers: VID 786 of 2012 VID 787 of 2012 VID 788 of 2012 VID 789 of 2012 VID 790 of 2012 VID 791 of 2012 Judge: GORDON J Date of judgment: 12 September 2013 Date of Corrigendum: 19 September 2013 Catchwords: TAXATION – income tax – allowable deductions – Income Tax Assessment Act 1997 (Cth), s 8-1 – imposts payable to State Treasurer pursuant to s 163AA of the Electricity Industry Act 1993 (Vic) – nature of payments – incurred in gaining or producing assessable income – loss or outgoing of capital or in the nature of capital Legislation: Electricity Industry Act 1993 (Vic) Income Tax Assessment Act 1936 (Cth) Income Tax Assessment Act 1997 (Cth) Cases cited: British Insulated and Helsby Cables Ltd v Atherton [1926] AC 205 City Link Melbourne Ltd v Commissioner of Taxation (2004) 141 FCR 69 Coles Myer Finance Ltd v Federal Commissioner of Taxation (1993) 176 CLR 640 Colonial Mutual Life Assurance Society Ltd v Federal Commissioner of Taxation (1953) 89 CLR 428 Commissioner of Taxation (WA) v Boulder Perseverance Ltd (1937) 58 CLR 223 Commissioner of Taxation v Citibank Ltd & Ors (1993) 44 FCR 434 Commissioner of Taxation v Morgan (1961) 106 CLR 517 Federal Commissioner of Taxation v Ashwick (Qld) No 127 Pty Ltd (2011) 192 FCR 325 Federal Commissioner of Taxation v Australian Guarantee Corp Ltd (1984) 2 FCR 483 Federal Commissioner of Taxation v Citylink Melbourne Limited (2006) 228 CLR 1 Federal Commissioner of Taxation v James Flood Pty Ltd (1953) 88 CLR 492 Federal Commissioner of Taxation v South Australian Battery Makers Pty Ltd (1978) 140 CLR 645 Federal Commissioner of Taxation v Star City Pty Ltd (2009) 175 FCR 39 Federal Commissioner of Taxation v Sutton Motors (Chullora) Wholesale Pty Ltd (1985) 157 CLR 277 Federal Commissioner of Taxation v The Midland Railway Co of Western Australia Ltd (1952) 85 CLR 306 GP International Pipe Coaters Pty Ltd v Federal Commissioner of Taxation (1990) 170 CLR 124 Hallstroms Pty Ltd v Federal Commissioner of Taxation (1946) 72 CLR 634 Layala Enterprises Pty Ltd (in liq) v Commissioner of Taxation (1998) 86 FCR 348 Magna Alloys & Research Pty Ltd v Federal Commissioner of Taxation (1980) 11 ATR 276 Moffatt v Webb (1913) 16 CLR 120 Morris & Ors v Federal Commissioner of Taxation (2002) 50 ATR 104 New Zealand Flax Investments Ltd v Federal Commissioner of Taxation (1938) 61 CLR 179 Pondicherry Railway Co Ltd v Commissioner of Income Tax, Madras (1931) LR 58 Ind App 239 Ronpibon Tin NL & Tongkah Compound NL v Federal Commissioner of Taxation (1949) 78 CLR 47 Sun Newspapers Ltd v Federal Commissioner of Taxation; Associated Newspapers Limited v The Federal Commissioner of Taxation (1938) 61 CLR 337 Tata Hydro-Electric Agencies Ltd, Bombay v Commissioner of Income Tax, Bombay Presidency and Aden [1937] AC 685 The Herald & Weekly Times Limited v Federal Commissioner of Taxation (1932) 48 CLR 113 The Midland Railway Co of Western Australia Ltd v Federal Commissioner of Taxation (1950) 81 CLR 384 United Energy Ltd v Federal Commissioner of Taxation (1997) 78 FCR 169 Visy Industries USA Pty Ltd v Commissioner of Taxation (2011) 85 ATR 232 Date of hearing: 16 July 2013 Date of last submissions: 16 July 2013 Place: Melbourne Division: GENERAL DIVISION Category: Catchwords Number of paragraphs: 100 Counsel for the Applicant: Mr DH Bloom QC with Ms LA Hespe Solicitor for the Applicant: King & Wood Mallesons Counsel for the Respondent: Ms HM Symon SC with Mr EF Wheelahan Solicitor for the Respondent: Maddocks Lawyers FEDERAL COURT OF AUSTRALIA SPI Power Net Pty Ltd v Commissioner of Taxation [2013] FCA 924 CORRIGENDUM 1. In paragraph 1 of the Reasons for Judgment, in the fourth sentence, delete the words "SPI acquired the transmission business" and insert the words "SPI Australia Holdings Pty Limited acquired all of the issued capital of SPI". 2. In paragraph 35 of the Reasons for Judgment, in the second sentence, delete the date "6 November 2007" and insert the date "6 November 1997". 3. In paragraph 37 of the Reasons for Judgment, in the second sentence, delete the words "SPI acquired the business" and insert the words "SPIAH acquired all of the issued capital of SPI". 4. In paragraph 39 of the Reasons for Judgment, in the first sentence, delete the date "7 October 2012" and insert the date "7 October 2011". I certify that the preceding four (4) numbered paragraphs are a true copy of the Corrigendum to the Reasons for Judgment herein of the Honourable Justice Gordon. Associate: Dated: 19 September 2013 IN THE FEDERAL COURT OF AUSTRALIA VICTORIA DISTRICT REGISTRY GENERAL DIVISION VID 786 of 2012 BETWEEN: SPI POWERNET PTY LTD Applicant AND: COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA Respondent JUDGE: GORDON J DATE OF ORDER: 12 september 2013 WHERE MADE: MELBOURNE THE COURT ORDERS THAT: 1. By 4:00pm on 19 September 2013, the parties are directed to bring in orders to give effect to these reasons for judgment. Note: Entry of orders is dealt with in Rule 39.32 of the Federal Court Rules 2011 (Cth). IN THE FEDERAL COURT OF AUSTRALIA VICTORIA DISTRICT REGISTRY GENERAL DIVISION VID 787 of 2012 BETWEEN: SPI POWERNET PTY LTD Applicant AND: COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA Respondent JUDGE: GORDON J DATE OF ORDER: 12 september 2013 WHERE MADE: MELBOURNE THE COURT ORDERS THAT: 1. By 4:00pm on 19 September 2013, the parties are directed to bring in orders to give effect to these reasons for judgment. Note: Entry of orders is dealt with in Rule 39.32 of the Federal Court Rules 2011 (Cth). IN THE FEDERAL COURT OF AUSTRALIA VICTORIA DISTRICT REGISTRY GENERAL DIVISION VID 788 of 2012 BETWEEN: SPI POWERNET PTY LTD Applicant AND: COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA Respondent JUDGE: GORDON J DATE OF ORDER: 12 SEPTEMBER 2013 WHERE MADE: MELBOURNE THE COURT ORDERS THAT: 1. By 4:00pm on 19 September 2013, the parties are directed to bring in orders to give effect to these reasons for judgment. Note: Entry of orders is dealt with in Rule 39.32 of the Federal Court Rules 2011 (Cth). IN THE FEDERAL COURT OF AUSTRALIA VICTORIA DISTRICT REGISTRY GENERAL DIVISION VID 789 of 2012 BETWEEN: SPI POWERNET PTY LTD Applicant AND: COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA Respondent JUDGE: GORDON J DATE OF ORDER: 12 SEPTEMBER 2013 WHERE MADE: MELBOURNE THE COURT ORDERS THAT: 1. By 4:00pm on 19 September 2013, the parties are directed to bring in orders to give effect to these reasons for judgment. Note: Entry of orders is dealt with in Rule 39.32 of the Federal Court Rules 2011 (Cth). IN THE FEDERAL COURT OF AUSTRALIA VICTORIA DISTRICT REGISTRY GENERAL DIVISION VID 790 of 2012 BETWEEN: SPI POWERNET PTY LTD Applicant AND: COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA Respondent JUDGE: GORDON J DATE OF ORDER: 12 SEPTEMBER 2013 WHERE MADE: MELBOURNE THE COURT ORDERS THAT: 1. By 4:00pm on 19 September 2013, the parties are directed to bring in orders to give effect to these reasons for judgment. Note: Entry of orders is dealt with in Rule 39.32 of the Federal Court Rules 2011 (Cth). IN THE FEDERAL COURT OF AUSTRALIA VICTORIA DISTRICT REGISTRY GENERAL DIVISION VID 791 of 2012 BETWEEN: SPI POWERNET PTY LTD Applicant AND: COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA Respondent JUDGE: GORDON J DATE OF ORDER: 12 SEPTEMBER 2013 WHERE MADE: MELBOURNE THE COURT ORDERS THAT: 1. By 4:00pm on 19 September 2013, the parties are directed to bring in orders to give effect to these reasons for judgment. Note: Entry of orders is dealt with in Rule 39.32 of the Federal Court Rules 2011 (Cth). IN THE FEDERAL COURT OF AUSTRALIA VICTORIA DISTRICT REGISTRY GENERAL DIVISION VID 786 of 2012 VID 787 of 2012 VID 788 of 2012 VID 789 of 2012 VID 790 of 2012 VID 791 of 2012 BETWEEN: SPI POWERNET PTY LTD Applicant AND: COMMISSIONER OF TAXATION OF THE COMMONWEALTH OF AUSTRALIA Respondent JUDGE: GORDON J DATE: 12 SEPTEMBER 2013 PLACE: MELBOURNE REASONS FOR JUDGMENT INTRODUCTION 1 The applicant, SPI, derives assessable income from providing access to the electricity transmission network in Victoria. Under s 159 of the Electricity Industry Act 1993 (Vic) (the EIA), SPI must hold a licence to transmit that electricity. Pursuant to an Order of the Governor in Council made under s 163AA of the EIA, payments were made by the licensee of the transmission business to the State Treasurer totalling $177.5 million during the financial years 1998 to 2000 (the s 163AA imposts). SPI acquired the transmission business on 30 June 2000. After SPI's acquisition, SPI self-amended its tax returns for the 1999 and 2000 tax years and claimed deductions for the amount of the s 163AA imposts paid to the State Treasurer. SPI then claimed a deduction for the s 163AA impost it paid in the 2001 tax year. The payments totalled $177.5 million. Are the s 163AA imposts deductible by SPI under s 8-1 of the Income Tax Assessment Act 1997 (Cth) (the 1997 Act)? 2 For the reasons that follow, the answer to that question is no. These reasons for judgment will consider electricity generation and supply, identify the relevant entities and concepts, then describe the privatisation of the electricity industry in Victoria (including the introduction of the s 163AA imposts) and, finally, consider whether the s 163AA imposts are deductible by SPI under s 8-1 of the 1997 Act. BACKGROUND Electricity Generation and Supply 3 The supply of electricity begins with generation in power stations. Electricity generators are usually located near fuel sources such as coal-mines, natural gas pipelines or hydro-electric water reservoirs. Because most end customers are located a long distance from generators, the supply chain requires transmission network systems to transport electricity. These networks fall into two categories: (a) high-voltage transmission networks, which transport electricity from generators to substations in metropolitan and regional areas; and (b) low-voltage transmission networks, which distribute electricity from these points to customers in cities, towns and regional communities. Relevant Entities and Concepts 4 Power Net Victoria (PNV) was a state-owned corporation established (as "National Electricity") by s 13 of the EIA. From 1994, it owned, maintained and operated the existing high voltage transmission network system or "grid" in Victoria. 5 The taxpayer, SPI, ultimately came to assume ownership of PNV's transmission business as a result of the following transactions. The business and assets of PNV were sold to Australian Transmission Corporation Pty Ltd (ATC) pursuant to an Asset Sale Agreement dated 12 October 1997 (the Asset Sale Agreement). It will be necessary to return to consider the terms of that agreement. 6 On 30 October 1997, ATC changed its name to GPU PowerNet Pty Ltd (GPU). GPU was a wholly owned subsidiary of GPU Inc, a company incorporated in the USA. On 30 June 2000, SPI Australia Holdings Pty Limited (SPIAH) acquired all of the issued capital of GPU. GPU changed its name to SPI on 2 July 2000. SPIAH and SPI were ultimately owned by Singapore Power International Pte Ltd, a company incorporated in Singapore. 7 SP Australia Networks (Transmission) Ltd (SPANT) became the Australian ultimate holding company of SPIAH and SPI on 19 October 2005. SPANT formed a tax consolidated group on the date SPI became a subsidiary member. Privatisation of the Electricity Industry in Victoria 8 Following the election in October 1992, the State Government of Victoria implemented a policy to review the structure and operation of the then publicly owned and operated electricity supply industry. At that time, the State Electricity Commission of Victoria (SECV) was responsible for most generation, all transmission and the majority of distribution and supply of electricity in Victoria. There were also metropolitan Municipal Electrical Undertakings (MEUs) which accounted for the remaining distribution and supply. 9 As part of the first stage of the restructure of the industry, on 10 August 1993, the Victorian Government announced its intention to disaggregate the SECV into three new operating businesses to respectively undertake the generation, transmission and distribution of electricity. The three businesses, Generation Victoria, National Electricity (later known as PNV) and Electricity Services Victoria, were established as state bodies under the State Owned Enterprises Act 1992 (Vic) in early October 1993 and commenced full operations from January 1994. 10 On 14 December 1993, royal assent was given to the EIA which, amongst other things, established PNV to undertake the transmission of electricity in Victoria. The EIA came into full force on 3 January 1994. 11 The second stage of the restructure of the industry undertaken in 1994 involved the restructuring of the three State electricity companies and the MEUs into eight new companies: 1. PNV; 2. Victorian Power Exchange (VPX), an independent company to operate the wholesale electricity market and ensure the security of supply; 3. Generation Victoria (GenVic), an interim generation structure comprising groups of power stations; and 4. Five regionally based distribution companies consisting of the former SECV distribution assets and the MEUs. Each comprised a retail arm and a regulated local geographic distribution or wires business. The distribution function obtained income by collecting regulated connection and distribution network charges. The principal function of the retail arm was to buy and sell electricity. During a transition phase to December 2000, each distribution company was the sole retailer of electricity to franchise customers in a defined franchise area until those customers were able to choose their retailer. 12 The third stage of the restructure, on 31 January 1995, involved the disaggregation of GenVic into five independent generation companies and the privatisation of the distribution and generation companies. 13 Although, at the time of the initial reforms, it had been intended that PNV would remain state-owned, in April 1997 the Victorian Government announced its intention to privatise PNV. This proceeding is concerned with one aspect of the privatisation of PNV. Tariff Regime – Regulation of Pricing and Charging 14 Whilst the Government's aim was that industry prices would come to be determined by market forces, there were several areas of the industry in which price and service controls needed to be applied during, and in some cases after, the reform process. First, until all customers were able to choose their supplier, retail pricing regulation was required for those customers tied to a single supplier. Second, a limit on the charges that could be applied to network services by distribution companies was required to prevent abuse of market power. Third, a regulatory regime was required to control the costs of connections to, and use of, the distribution and transmission systems. 15 The mechanism by which these price controls were to be applied and maintained was a Tariff Order made under s 158A of the EIA on 20 June 1995 (the Tariff Order). 16 The Tariff Order included: 1. Retail tariffs, of which there were two categories – one which applied to franchise customers (called the Maximum Uniform Tariff (MUT)) and one which applied to contestable customers (which related only to network tariff components). For the period up to 31 December 2000, tariffs for the sale of electricity to "franchise customers" were capped in the form of the MUT set out in the Tariff Order; 2. Distribution network charges which could be levied by the distribution businesses for supplying electricity through the distribution network; and 3. Charges levied by PNV for "Prescribed Services", being network services provided to VPX and connection services to distribution businesses, generators, traders and some large customers. Tariff Order for PNV 17 PNV was regulated by the provisions of the EIA, its transmission licence, the Tariff Order and, upon its commencement, the National Electricity Code. The Tariff Order imposed a pre-determined cap on the revenue which PNV could derive from the provision of "Prescribed Services". "Prescribed Services" were defined by cl 3.1 of the Tariff Order (as amended by Order in Council dated 28 October 1997) as: (a) Network Services (as defined in Part A of Attachment 5) relating to the system existing as at 3 October 1994; (b) Connection Services (as defined in Part B of Attachment 5) relating to the connection facilities existing as at 3 October 1994; and (c) augmentation, between 3 October 1994 and 30 June 2000 to the system and the connection facilities existing as at 3 October 1994 as specified in Part C of Attachment 5. Insofar as the "Prescribed Services" included "Network Services" and "Connection Services", they were limited to the "levels required as of 3 October 1994". 18 PNV's gross revenue in respect of the provision of Prescribed Services for a financial year was not to exceed the Maximum Allowable Revenue (MAR) calculated in accordance with the Tariff Order for that financial year. The MAR was calculated as a product of the Maximum Allowable Charge (MAC) and the forecast Summer Maximum Demand (SMD). 19 The revenue cap in the Tariff Order was calculated to reflect three matters – efficient levels of operating and maintenance costs; a return on capital; and straight line depreciation at rates reflecting estimated useful lives on Current Cost Accounting asset base. The charges were set to enable PNV to recover the cost of its assets over time (reflecting depreciation), to provide it with a return on capital (using the Optimised Depreciated Replacement Cost value of assets multiplied by a weighted average cost of capital) and to recover its estimated operating and maintenance costs. To ascertain the tariff for each year, the initial tariff was adjusted by "CPI – X", where the X factor was a proxy for the expected real rate of improvement in efficiency. For the Tariff Order in effect from 3 October 1994 to 31 December 2000, the X factor was 0.0179. 20 The tariff structure gave PNV the ability to make a profit above the cost of capital by outperforming the cost assumptions on which the regulated return was calculated, at least until the tariff was reset. 21 Between the time when the X factor was initially calculated (and the Tariff Order determined in 1995) and the time that PNV was privatised in 1997, the State Government decided to extend the Tariff Order applicable to PNV for a further two years in order to promote price certainty for prospective purchasers of PNV. KPMG, as advisers to the Victorian Government, undertook a review of the assumptions adopted in the original tariff model and determined that some of the assumptions adopted in that model were no longer correct. As a result of changes in the rate of inflation, operational costs and the cost of capital, the level of MAR which the Tariff Order permitted PNV to earn was higher than that required to provide a reasonable return on capital. Consequently, the X factor in the Tariff Order needed to be reset to reflect this change in circumstance. 22 Mr Antony Cohen, at the relevant time the lead partner of KPMG's "Industry Restructuring and Privatisations Group", provided sworn evidence. In this role, Mr Cohen advised the Victorian Government on financial, accounting and tax issues relating to the disaggregation and privatisation of the electricity industry in Victoria. KPMG was also responsible for modelling the tariffs that were to be charged by the newly established electricity industry entities. His unchallenged evidence was that resetting the X factor would have resulted in lower transmission charges. However, lowering transmission charges would have had some unintended – and undesirable – consequences. Because the tariffs charged by the distribution entities were fixed for the period to 31 December 2000, lowering the price for transmission services would provide a windfall benefit to the owners of the privatised distributors who were charging a fixed retail price for electricity but incurring lower costs. Passing the lower transmission charges on to the ultimate consumer was not considered practical given the number of customers and the small savings per customer. 23 In the absence of a change to the Tariff Order, Mr Cohen's unchallenged evidence was that PNV would derive more revenue than it required in order to earn an appropriate return on capital having regard to its expected operating costs. It was therefore proposed that the difference between the gross revenue that would accrue to PNV under the Tariff Order, and the MAR that the modelling concluded should have been derived in the period before the Tariff Order lapsed in December 2000, would be recovered from PNV by way of a "special licence fee" that would be separately invoiced and levied by s 163AA of the EIA. PNV's revenue from "Prescribed Services" and the effect of the imposition of the Licence Fee was depicted diagrammatically in an "Information Memorandum for the Proposed Sale of PowerNet Victoria" dated August 1997 (the Information Memorandum) as follows: 24 The Tariff Order also set out a list of "Excluded Services" relating to the transmission system. They included augmentation (other than the specified augmentation) and the provision of technical, consulting and other services. The Excluded Services were contestable; that is they were not monopolistic. As the Information Memorandum recorded: The tender process [was] designed to deliver a competitive market price for the augmented transmission service. Tenderers bid a long-term ... charge to be paid by VPX for the augmentation. As the price is determined in a competitive process, there is no need for on-going regulation of the price for that service. VPX effectively recovers this increased cost of transmission services through transmission use of system charges to the [distribution businesses] … 25 On 23 June 1997, the Treasurer of Victoria approved a change to the Tariff Order applying to PNV. The X factor for the 2001 and 2002 years was to be increased and fees were to be imposed. 26 As part of the PNV privatisation process, the Information Memorandum was provided to potential bidders. The Information Memorandum disclosed that the X factor for the year from 1 January 2001 to 31 December 2002 was to increase to 11% and that it was intended that an Order would be made under s 163AA of the EIA imposing the following specified charges on the holder of the PNV transmission licence (referred to as the "licence fee"): (a) $50 million per annum for each of the years ending 30 June 1998 to 30 June 2000; and (b) $40 million for the year ending 30 June 2001. The specified charges will be fixed amounts and payable quarterly in arrears for each financial year to 30 June 2000 and equal instalments payable on 30 September and 31 December 2000, in respect of the year ending 30 June 2000. It is intended that charges under section 163AA will not be imposed from 31 December 2000. 27 Section 163AA of the EIA was inserted by s 13 of the Electricity Industry (Further Amendment) Act 1995 (Vic). At all relevant times, it was in the following terms: (1) The Governor in Council, on the recommendation of the Treasurer, may, by Order published in the Government Gazette, declare that specified charges, or charges calculated in a specified manner, are payable as an impost by the holder of a licence at such times and in such manner as are so specified. (2) The holder of a licence must pay to the Treasurer for payment into the Consolidated Fund the charges determined under sub-section (1) and applicable to the licence at the times and in the manner so determined. … (Emphasis added.) 28 GPU Inc submitted its bid to the Victorian Government for the acquisition of the PNV assets on 10 October 1997. In its bid document, GPU Inc requested a change to the proposed s 163AA charges to reflect the fact that the sale would occur after the end of the first quarter of the financial year ended 30 June 1998. GPU Inc's bid was successful. 29 The Asset Sale Agreement between PNV (as the seller) and ATC (as the buyer) was executed on 12 October 1997. The State of Victoria was a party. The Recitals provided: A. [PNV] is the owner of the Assets. B. [PNV] agrees to sell and [ATC] agrees to buy the Assets (excluding the Land which will be allocated from [PNV] to [ATC]) on the terms and conditions set out in this agreement. … E. The total value attributed by the parties to the sale of Assets (net of Creditors and Contract Liabilities) the subject of this agreement is $2,555,000,000 made up of: Total Purchase Price $2,502,600,000 Estimated Duty $52,400,000 ______________ $2,555,000,000 ______________ F. The parties agree that the total payments to the State in connection with the privatisation of [PNV] are $2,732,500,000 (including future licence fees of $177,500,000 payable by [ATC], which the State values in net present value terms at approximately $161,000,000). "Assets" was a defined term and included the Transmission Licence: cl 1.1. 30 On the Completion Date, PNV sold and ATC bought the Assets (excluding the Land), ATC assumed certain creditors and ATC paid the Total Purchase Price. The phrase "Total Purchase Price" was defined to mean: $2,502,600,000 being the sum of the price of the Assets (including the Land) net of Contract Liabilities and Creditors … assumed under this agreement, and, for the avoidance of doubt, does not include the Estimated Duty. … 31 Clause 4.3 of the agreement set out the conditions precedent to completion. Relevantly, they included that: (a) the State, [PNV] and [ATC] shall procure that the Office of the Regulator-General approves the transfer of the Transmission Licence from [PNV] to [ATC] with effect from Completion; … (d) the State shall procure the publication in the Government Gazette of the Licence Fee Order; … 32 The "Licence Fee Order" was defined to mean the orders set out in Annexure G and was as follows: Electricity Industry Act 1993 Order under section 163AA Order declaring the charges payable by [PNV] to the Treasurer for payment into the Consolidated Fund in respect of the licence to transmit electricity issued to [PNV] under Part 12 of the Electricity Industry Act 1993. The Governor in Council acting on the recommendation of the Treasurer under section 163AA of the Electricity Industry Act 1993 declares that the amounts payable as an impost by [PNV], as the holder of a licence (the "Transmission Licence") to transmit electricity issued under Part 12 of the Electricity Industry Act 1993, to the Treasurer for payment into the Consolidated Fund under section 163AA of the Electricity Industry Act 1993 are as follows: (a) $37,500,000 in respect of the financial year ending 30 June 1998, payable in arrears in two instalments, being $25,000,000 on 31 March 1998 and $12,500,000 payable on 30 June 1998; (b) $50,000,000 in respect of each of the financial years ending 30 June 1999 and 30 June 2000, payable in arrears in four equal instalments on 30 September, 3l December, 31 March and 30 June in each relevant financial year; and (c) $40,000,000 in respect of the 6 months ending on 31 December 2000, payable in arrears in two equal instalments on 30 September 2000 and 31 December 2000. This Order applies to any person or persons (jointly and severally) to which the Transmission Licence is transferred or any person or persons (jointly and severally) which acquires all or substantially all the business of [PNV] or any subsequent holder of the Transmission Licence and which is or are issued with a licence to transmit electricity under Part 12 of the Electricity Industry Act 1993. 33 The Seller's Warranties were set out in cl 13 of the Asset Sale Agreement. Clause 13.3(d) provided that ATC acknowledged and agreed with the State and PNV that: (1) the amounts to be payable by [ATC] pursuant to the Licence Fee Order are an integral part of the regulatory framework of the industry and [ATC] accepts that it must pay the amounts set out in the Licence Fee Order in order to carry on the Business transferred from [PNV]; (2) [ATC] must not challenge the validity of the Licence Fee Order or the amounts, or the basis of calculating the amounts, specified in the Licence Fee Order; (3) [ATC] agrees to pay to the Treasurer the amounts specified in the Licence Fee Order in accordance with the terms of, and at the times specified in, the Licence Fee Order, whether or not the Licence Fee Order is valid or enforceable; and (4) [ATC] must not transfer the Transmission Licence or allow any person to become a licensee under the Transmission Licence unless the proposed licensee has first delivered to the State a covenant (in form and substance satisfactory to the State) agreeing to be bound by this clause 13.3(d) as if it were the Buyer. (Emphasis added.) "Business" was defined in the Asset Sale Agreement to mean "the business of the design, ownership, augmentation and maintenance of the parts of the Victorian electricity transmission system owned by [PNV] (and subsequently [ATC]), the provision of connection services and other activities carried on by [PNV] (and subsequently [ATC]) including diagnostic testing". 34 On 28 October 1997, the Governor in Council made an Order amending the Tariff Order under s 158C(3) of the EIA and a further Order pursuant to s 163AA declaring that: [T]he amounts payable as an impost by [PNV] as the holder of a licence (the "Transmission Licence") to transmit electricity issued under Part 12 of the [EIA] to the Treasurer for payment into the Consolidated Fund under Section 163AA(2) of the [EIA], are as follows: (a) $37,500,000 in respect of the financial year ending 30 June 1998, payable in arrears in two instalments being $25,000,000 on 31 March 1998 and $12,500,000 payable on 30 June 1998; (b) $50,000,000 in respect of each of the financial years ending 30 June 1999 and 30 June 2000, payable in arrears in four equal instalments on 30 September, 31 December, 31 March and 30 June in each relevant financial year; and (c) $40,000,000 in respect of the 6 months ending on 31 December 2000, payable in arrears in two equal instalments on 30 September 2000 and 31 December 2000. This Order applies to any person or persons (jointly and severally) to whom the Transmission Licence is transferred or any subsequent holder of the Transmission Licence or any person or persons (jointly and severally) who acquire all or substantially all of the business of [PNV] and who is or are issued with a licence to transmit electricity under Part 12 of the [EIA]. The last paragraph of the Order applied to SPI because it acquired PNV's business, including PNV's transmission licence. 35 The transfer of the Transmission Licence to SPI under the Asset Sale Agreement was approved by the Office of the Regulator-General on 3 November 1997. The Asset Sale Agreement was completed on 6 November 2007. 36 As is apparent, the s 163AA imposts were payable to the State over and above the purchase price: see [29] above. The s 163AA imposts payable for the year ended 30 June 1998 were adjusted downwards by $12.5 million to reflect that the Order would not take effect until after the first quarter of that financial year. 37 While the transmission business was owned by GPU Inc, no claim was made for income tax deductions in relation to the s 163AA imposts. However, after SPI acquired the business on 30 June 2000, SPI self-amended its tax returns for the 1999 and 2000 income tax years and claimed a deduction for the payment of the s 163AA imposts in those years. In the 2001 income tax year, SPI claimed a deduction for its payment of the s 163AA impost. The imposts totalled $177.5 million as follows: Deductible Item Year ended 31 December 1998 (Amended) (1999 income tax year) Year ended 31 December 1999 (Amended) (2000 income tax year) Year ended 31 December 2000 (2001 income tax year) Section 163AA $62,500,000 $50,000,000 $65,000,000 Each year was a "Loss Year". As a result, in calculating its taxable income for the substituted accounting periods ended 31 March 2002, 31 March 2003, 31 March 2004 and 31 March 2005, SPI claimed a deduction on account of losses referable to the Loss Years. Following the formation of the SPANT tax consolidated group, SPI re-calculated its taxable income for the substituted accounting period ended 31 March 2006. In doing so, SPI utilised a tax loss referable to the Loss Years. Procedural History 38 On or about 15 December 2008, the Commissioner commenced an audit of the SPANT tax consolidated group and subsequently issued amended assessments disallowing the deductions claimed or carried forward losses used by SPI for the 2001 to 2006 income tax years. 39 On or about 7 October 2012, SPI objected to the Commissioner's amended assessments for the 2001 to 2006 income tax years. On 15 August 2012, the Commissioner issued a notice of objection decision disallowing SPI's objection. LEGISLATION AND RELEVANT LEGAL PRINCIPLES FOR DEDUCTIBILITY Legislative Provisions 40 Section 8-1 of the 1997 Act provides: (1) You can deduct from your assessable income any loss or outgoing to the extent that: (a) it is incurred in gaining or producing your assessable income; or (b) it is necessarily incurred in carrying on a *business for the purpose of gaining or producing your assessable income. (2) However, you cannot deduct a loss or outgoing under this section to the extent that: (a) it is a loss or outgoing of capital, or of a capital nature; … ISSUES 41 In calculating its tax loss in each Loss Year, was SPI entitled to a deduction under s 8-1 of the 1997 Act for the whole or some part of the s 163AA imposts? It was not in dispute that the s 163AA imposts were an outgoing incurred by SPI. It was also not in dispute that SPI carries on a business for the purpose of gaining or producing assessable income. 42 What then were the parties' respective positions? SPI contended that the s 163AA imposts were deductible because the imposts satisfied both positive limbs of s 8-1(1) and were not outgoings of capital, or of a capital nature, within s 8-1(2). SPI further submitted that the s 163AA imposts were distinguishable from the franchise fees payable in United Energy v Federal Commissioner of Taxation (1997) 78 FCR 169 because they did not secure any monopoly for SPI. Further, SPI contended that the s 163AA imposts were not precluded from deductibility because they took the form of a compulsory exaction and did not involve a sharing of profits between SPI and the State of Victoria. 43 The Commissioner disagreed. He contended that the payments were a compulsory exaction of profits and, accordingly, were not outgoings incurred by SPI in gaining or producing its assessable income nor incurred by it in the course of carrying on its business. Moreover, the Commissioner contended that the payments were outgoings of capital, or of a capital nature. In particular, he contended that the character of the advantage sought, and gained, by the payments was freedom from competition in providing network and connection services to the Victorian electricity transmission system existing as at 3 October 1994 and in providing prescribed augmentation to that system. Alternatively, the Commissioner contended that because of the specific obligation to make the payments (expressed in cl 13.3(d) of the Asset Sale Agreement (see [33] above)), the payments were made in acquiring that part of the profit yielding structure represented by the lasting benefits to the operator of the transmission business provided by the regulatory framework in which it was conducted. ANALYSIS Section 8-1(1) – Loss or outgoing incurred in gaining or producing assessable income or carrying on a business for that purpose 44 SPI must establish that the whole, or some part, of the s 163AA imposts was incurred in gaining or producing its assessable income or in carrying on a business for that purpose. The Commissioner contended that the s 163AA imposts were a compulsory exaction of profits and, accordingly, were not outgoings incurred by SPI in gaining or producing its assessable income nor incurred by it in the course of carrying on its business. 45 The relevant principles were not in dispute. For a payment to satisfy s 8-1(1), there must be a sufficient nexus between the expenditure and the taxpayer's income producing operations and activities: Ronpibon Tin NL & Tongkah Compound NL v Federal Commissioner of Taxation (1949) 78 CLR 47 at 57. In assessing that nexus, it was common ground that a matrix of circumstances formed the background to the Asset Sale Agreement and the imposition of the s 163AA imposts: Federal Commissioner of Taxation v Star City Pty Ltd (2009) 175 FCR 39 at [60]-[61] and the authorities there cited. 46 Before turning to the application of these principles, it is necessary to say something about the materials adduced as part of that matrix. The materials fell into two groups. The first group comprised contemporaneous materials in the possession of, or otherwise available to, SPI including the Asset Sale Agreement and the Information Memorandum. Those materials form part of the matrix of circumstances. 47 The second group is more problematic. It comprised three publications released by the Department of Treasury and Finance (DTF) and the Office of State Owned Enterprises (OSOE) and numerous memoranda internal to those entities and their advisers dated 20 November 1996 to 15 October 1997. There was no evidence that any of these documents were available to SPI or were considered by SPI (in contrast, the Information Memorandum specifically directed prospective purchasers to a fourth publication released by the DTF and OSOE). In the circumstances, none of these documents form part of the matrix of circumstances. To the extent that those documents record, or contain, information or facts not recorded elsewhere, the facts and information set out in those documents do not form part of the matrix. 48 The fact that the documents listed in [47] above may be put to one side is not surprising. The character of an outlay is determined by reference to the payer's purposes, not the recipient's: Visy Industries USA Pty Ltd v Commissioner of Taxation (2011) 85 ATR 232 at [125]. Put another way, deductibility is determined by reference to the business purpose for which the outgoing was incurred from SPI's (not the recipient's) point of view: Federal Commissioner of Taxation v The Midland Railway Co of Western Australia Ltd (1952) 85 CLR 306 at 313 and Federal Commissioner of Taxation v Ashwick (Qld) No 127 Pty Ltd (2011) 192 FCR 325 at [103]-[104]. 49 As Dixon J (as he then was) said in Midland Railway (at 313): [W]hat governs the issue is the business purposes for which the outgoing was incurred from the point of view of the taxpayer company. The controlling factors are those which arise from the character of the business or undertaking and the relation which the expenditure or the liability to make it bore to the carrying on of the business or the gaining of assessable income. 50 The question of whether expenditure is incurred for the purpose of carrying on a business is to be determined objectively by reference to the relationship between what the expenditure is for and the taxpayer's undertaking or business: Magna Alloys & Research Pty Ltd v Federal Commissioner of Taxation (1980) 11 ATR 276 at 287 and Ashwick (Qld) No 127 at [103]-[105]. 51 What then were the business purposes for which the s 163AA imposts were incurred from SPI's perspective? As we have seen, the controlling factors are the character of the business and the relation which the s 163AA imposts bore to that business. 52 SPI was the holder of a licence to transmit electricity energy under Pt 12 of the EIA: see [35] above. SPI derived its assessable income from carrying on its transmission business which included providing "Prescribed Services" to VPX as the operator of the electricity network and from connecting generators, distributors and large customers to the electricity network: see [17] above. To carry on that business, it was required to hold the transmission licence: s 159 of the EIA. The s 163AA imposts were imposed on it because it was the holder of the transmission licence. The payment of the s 163AA imposts was incidental to and arose as a consequence of the conduct of SPI's business; the s 163AA imposts were inseparably connected with the transmission licence which SPI used for business purposes. 53 So far so good. However, the Commissioner submitted that the s 163AA imposts were not deductible because the payments were a compulsory exaction of profits and were therefore not outgoings incurred by SPI in gaining or producing its assessable income nor incurred by SPI in the course of carrying on its business. In support of that contention, the Commissioner relied upon the reasoning of Lockhart J in United Energy. SPI disagreed. SPI contended that the s 163AA imposts were not precluded from deductibility because they were a compulsory exaction. 54 Are there relevant principles and, if so, what are they? First, the mere fact that an exaction is compulsory does not of itself deny deductibility. As SPI submitted, there were, and are, many taxes which are deductible – land tax, the former sales tax, council rates and payroll tax: see, by way of example, Moffatt v Webb (1913) 16 CLR 120; Commissioner of Taxation v Morgan (1961) 106 CLR 517; Layala Enterprises Pty Ltd (in liq) v Commissioner of Taxation (1998) 86 FCR 348; and City Link Melbourne Ltd v Commissioner of Taxation (2004) 141 FCR 69 at [53]. 55 Moffatt is instructive. The deduction claimed was for land tax imposed by the Land Tax Assessment Act 1910 (Cth) on land on which the taxpayer carried on his business as a grazier. The Court held that the land tax was an outgoing incurred by the grazier in production of income and was therefore deductible. Justice Isaacs (as he then was) put the issue simply – could the federal land tax be considered as incurred in the production of income because the grazier was bound to pay the tax as owner, regardless of what he did with the land: at 134. In seeking to answer that question, the purpose for which the tax was enacted was "utterly immaterial": at 135. The taxpayer must if he carried on that business or trade pay the tax. It was the legislature which made the taxpayer pay it and it was not a thing open to his own will or option. As Isaacs J stated, the land was as necessary to the business as the personal property – the grass, water and shelter, which were indispensable to the production of the grazier's income. The grazier's actual gross return could not be received without the use of the land. The use of the land was the use of an instrument to which was attached by law a compulsory payment. Justice Isaacs concluded (at 136) that it: follow[ed] naturally that the payment made under compulsion of law in respect of that necessary element of the business income [was] an outgoing made in the production of the income and in the circumstances ... it was made wholly and exclusively for the taxpayer's business. 56 In order to put the issue beyond doubt, Isaacs J identified (at 136) the "fallacy of the contrary doctrine": … it confuses, not so much the meaning, as the application of the word "purpose". The land tax is enacted by the legislature for its own purpose, that is, to tax the owner; and when he pays it to the Crown, he pays it as the owner, it is true, but so far, not for any purpose of his. He simply pays it because he is obliged to by law. But when he uses the property to produce an income, that is, for his business purposes, he pays the tax inseparably connected with the land also for his business purposes, namely as an outlay necessary in the existing state of the law to obtain that income by means of that land. 57 Applying those principles to the s 163AA imposts, the result would appear to be the same. The Victorian Government enacted the s 163AA imposts for its own purpose – to impose a "Licence Fee" on the holder of the Transmission Licence. SPI paid it because it was obliged to pay it. It held the Transmission Licence to produce an income for its business purposes and the payment of the s 163AA imposts was inseparably connected with the Transmission Licence – an outlay necessary on the existing state of the law to obtain income by using the Transmission Licence. Put another way, the thing which produced the assessable income was the thing which exposed the taxpayer to the liability discharged by the expenditure: see The Herald & Weekly Times Limited v Federal Commissioner of Taxation (1932) 48 CLR 113 at 118. 58 The question which then arises is whether United Energy leads to a different result. The Commissioner submitted that it does. United Energy distributed and sold electricity in Victoria. United Energy was one of the five regionally based distribution companies referred to in [11] above. It was licensed under the EIA to sell electricity exclusively in a designated geographical area of Victoria. During the transition phase to a "fully contestable" retail market, the distribution businesses had a statutory monopoly over the franchise customers at a supply price set by the Government. Because the MUT was set for each franchise customer class regardless of location, in many cases the MUT exceeded the total expected cost of electricity supply. Franchise fees to capture the excess profits that would otherwise accrue to a retailer as a result of MUT's exceeding the forecast cost of supplying electricity to franchise customers were therefore applied to franchise customer sales during this transition phase. These fees were levied pursuant to s 163A of the EIA: (1) A distribution company that holds, or has held, an exclusive licence under this Part authorising it to sell electricity to franchise customers must pay to the Treasurer, in respect of each financial year during which it holds, or held, such a licence the impost determined in respect of that year by Order of the Governor in Council, on the recommendation of the Treasurer, applying to that company and published in the Government Gazelle— (a) if the licence is issued before 30 June 1996— (i) before 30 June 1995, in the case of the impost in respect of the financial year ending on that date; and (ii) before 30 June 1996, in the case of the impost in respect of each year ending on 30 June in the period beginning on 30 June 1996 and ending on 30 June 2001; and (b) if the licence is issued on or after 30 June 1996, before the end of the first year of the term of the licence. (2) The Treasurer, in recommending the amount of an impost for each financial year payable by a distribution company, must be satisfied that the amount reasonably represents the amount by which the income of the company derived from the sale of electricity to franchise customers in that year is likely to exceed the sum of— (a) the costs of deriving the income; and (b) taxes payable in deriving that income; and (c) an amount determined by the Treasurer to be a reasonable return on the capital of the company used in deriving that income— having regard to— (d) any relevant Order in force under section 158A; and (e) the value of property and rights vested in the company under Parts 10 and 11; and (f) the amount of liabilities that became liabilities of the company under Parts 10 and 11; and (g) the likely number of franchise customers of the company in that financial year; and (h) such other matters as the Treasurer determines after consultation with the company. (3) The impost in respect of a financial year is payable at such times and in such manner as are determined in the Order. (4) For the purposes of this section, a distribution company has an exclusive licence authorising the sale of electricity to franchise customers if that licence is the only licence in force under this Part authorising the sale of electricity to those customers. (Emphasis added.) 59 The Court described the s 163A imposts as "franchise fees". The issue before the Court was whether the franchise fees, levied against United Energy and paid, were deductible? Justice Lockhart decided that the franchise fees were akin to the State taking a share of United Energy's profits leaving United Energy with what the Treasurer determined to be a reasonable return on the capital of United Energy used in deriving its income: at 180. Justice Lockhart described the franchise fees as being in the nature of the payment of a dividend or the residual distribution of profits or dividends to the State: at 181. Put another way, Lockhart J stated that because they were compulsory exactions directed at United Energy's profits they were in the nature of a State tax on profits not a payment for services rendered or a cost incurred in the process of deriving income: at 180. Justice Lockhart said that the franchise fees were not deductible under s 51(1) of the Income Tax Assessment Act 1936 (Cth) (the 1936 Act) (the predecessor to s 8-1 of the 1997 Act). The majority (Sundberg and Merkel JJ) agreed with Lockhart J that the franchise fees were a compulsory exaction imposed by the Victorian Government to extract a share of the profits of United Energy: at 193. The majority accepted that characterisation but resolved the question of deductibility against United Energy on the basis that the amount was in the nature of capital, being profits extracted as a monopoly rent: at 193. It will be necessary to return to this part of the analysis in the next section of the reasons for judgment addressing s 8-1(2) of the 1997 Act. 60 As is readily apparent, the approach adopted by Isaacs J in Moffatt was substantially different to the approach adopted by Lockhart J. Justice Isaacs eschewed any reference to, or reliance on, the fact that the exaction was compulsory or the purpose of the State in imposing the liability to pay the tax. Justice Lockhart, on the other hand, regarded both those matters as not only significant but determinative of the question of the deductibility of the payment. 61 Can these authorities be reconciled? The answer is yes. First, as Lockhart J acknowledged, there are cases which support the proposition that "hidden taxes" payable in the course of carrying on a business may be deductible but, unsurprisingly, all cases depend on their facts: at 181. What then makes some "hidden taxes" deductible and others not? 62 The Commissioner submitted that "it is well established that a payment of profits is not a payment to earn profits and is therefore not deductible". In support of that proposition, the Commissioner cited the Privy Council's statement in Pondicherry Railway Co Ltd v Commissioner of Income Tax, Madras (1931) LR 58 Ind App 239. The Commissioner's submission puts the principle too high. In Pondicherry Railway, it was held (at 251-252) that: A payment out of profits and conditional on profits being earned cannot accurately be described as a payment made to earn profits. It assumes that profits have first come into existence. But profits on their coming into existence attract tax at that point, and the revenue is not concerned with the subsequent application of the profits. 63 This statement was considered by the High Court in The Midland Railway Co of Western Australia Ltd v Federal Commissioner of Taxation (1950) 81 CLR 384 (before Kitto J) and subsequently by the Full Court in Federal Commissioner of Taxation v The Midland Railway Co of Western Australia Ltd (1952) 85 CLR 306. 64 At first instance, Kitto J said (at 393): To say that it is payable out of profits or even out of net profits, is not to say that it is payable out of taxable income. Confusion may easily arise from cases dealing with the question whether particular payments are to be regarded as made in the course of ascertaining profits or out of profits when ascertained, because of the different senses in which the "profits" may be used. In this case, for instance, counsel for the Commissioner referred to the statement of the Privy Council in Pondicherry Railway Co Ltd v Commissioner of Income Tax, Madras, that "a payment out of profits and conditional on profits being earned cannot accurately be described as a payment made to earn profits. It assumes that profits have first come into existence. But profits on their coming into existence attract tax at that point, and the revenue is not concerned with the subsequent application of the profits." But, as Lord Greene M.R. pointed out in British Sugar Manufacturers Ltd v Harris, the word "profits" was there used in the sense of "real net profits"; and the statement is inapplicable to a case where the relevant question is whether the payments were incurred in producing, not real net profits (which may approximate to taxable income), but assessable income which by definition includes gross income … (Emphasis added. Citations omitted.) 65 On appeal, Dixon J (as he then was) said (at 312-313): … from beginning to end the issue is whether the payment or any part of it was an outgoing incurred in gaining or producing the assessable income or necessarily incurred in carrying on a business for the purpose of gaining or producing such income … it is not decisive of the issue under s 51(1) that it was paid or payable out of profits, that is so long as it was not payable out of the precise fund called by the Act taxable income. 66 These statements echoed the High Court's earlier consideration of Pondicherry Railway in Commissioner of Taxation (WA) v Boulder Perseverance Ltd (1937) 58 CLR 223 at 234: No doubt Lord Macmillan made too absolute a statement in Pondicherry Railway Co Ltd v Commissioner of Income Tax, Madras when he said that "a payment out of profits and conditional on profits being earned cannot accurately be described as a payment made to earn profits." In Indian Radio and Cable Communications Co Ltd v Income Tax Commissioner Lord Maugham said that it might be admitted that it is not universally true to say that a payment the making of which is conditional on profits being made cannot properly be described as an expenditure incurred for the purpose of earning such profits. (Citations omitted.) 67 As these cases demonstrate, broad sweeping statements by reference to the word "profits" do not assist in determining whether a payment is deductible. On the contrary, they ask the wrong question which leads, inevitably, to the wrong answer. The question to be asked is specific – whether the payment or any part of it is an outgoing incurred in gaining or producing the assessable income or necessarily incurred in carrying on a business for the purpose of gaining or producing such income. Subject to one matter, whether the s 163AA imposts were payments out of "profits" is not determinative. The one qualification is that if a payment is "payable out of the precise fund called by the Act taxable income", it is not deductible. That is not surprising – it would be contrary to established principle for a payment out of "taxable income" to be deductible. In general terms, your "taxable income" in a defined period is the result (or amount) after deducting allowable deductions from your assessable income (being all the income you have earned). The question therefore remains whether the s 163AA imposts, or any part of them, were an outgoing incurred in gaining or producing SPI's assessable income or necessarily incurred in carrying on its business for the purpose of gaining or producing such assessable income? 68 In answering that question, it is necessary to consider the process Lockhart J engaged in United Energy in determining the character of the franchise fees paid or payable under s 163A of the EIA. Justice Lockhart gave considerable weight to "the purpose of the State in imposing the liability to pay the tax". In doing so, Lockhart J had regard (at 180) to the legislation – the terms of the provision imposing the franchise fee (s 163A): see [58] above. Having regard to the manner in which the amount of the franchise fee was to be determined under s 163A, Lockhart J found (at 180) that: Properly analysed the franchise fees are in reality akin to the State of Victoria taking a share of the profits from the [distribution companies] (in this case the applicant), leaving the applicant an amount determined by the Treasurer to be a reasonable return on the capital of the company used in deriving the income (s 163A(2)(c)). The residue is taken by the State as its share of profits; it has similar characteristics to a payment by way of dividend. 69 Section 163A(2) expressly provided that the Treasurer's calculation of the franchise fee was to be undertaken after, or at least in part by, determining the distribution company's taxable income, not its assessable income: see [58] above. One step in the calculation was to determine the amount of income the company derived from the sale of electricity to franchise customers (the assessable income) less the costs of deriving that income (giving rise, in general terms, to the company's taxable income). A further step was then to deduct the taxes payable in deriving that income. Two further amounts were then calculated – a reasonable return on the capital used in deriving the assessable income and any "surplus". The "surplus" was expressed by s 163A to be the amount that reasonably represented the amount by which the assessable income was likely to exceed the total of the taxable income and the return on capital. The excess was "taxed" as the franchise fee. As is apparent, the franchise fee was a payment out of profits but a payment out of profits after the calculation of the entity's taxable income. It was not an outgoing incurred in gaining or producing the assessable income or necessarily incurred in carrying on a business for the purpose of gaining or producing such assessable income. 70 Section 163AA is in different terms. It does not prescribe how the impost is to be calculated. Having regard to the express terms of s 163AA alone, the Court could not be satisfied that the impost payments were payments of "profits", being a payment out of profits after the calculation of the entity's taxable income. Put another way, there is nothing on the face of s 163AA to suggest that SPI made the payments for any reason other than discharging an obligation to pay imposed upon it as the holder of the transmission licence. 71 The next question which arises is whether other material alters or affects that conclusion? The answer to that question is yes. 72 As the Tariff Order provided (and the Information Memorandum recorded), the purpose of the Tariff Order was to regulate pricing of services – it imposed a cap on the revenue which could be derived from the provision of "Prescribed Services": see [17]-[18] above. It must be recalled that the MAR (the Maximum Allowed Revenue) was in fact "MAC x SMD", where "MAC" was the "maximum average charge" and "SMD" was the "summer maximum demand". The subsequent amendments to the Tariff Order were similarly directed to deliver more predictable transmission pricing outcomes: see [21] above. These controls of (and amendments to) pricing affected the assessable income of PNV. 73 But the revenue cap in the Tariff Order was not limited to derivation of PNV's assessable income. The revenue cap in the Tariff Order was calculated to reflect three matters – efficient levels of operating and maintenance costs, a return on capital and straight line depreciation at rates reflecting estimated useful lives on Current Cost Accounting asset base: see [19] above. The charges were set to enable PNV to recover the cost of its assets over time (reflecting depreciation), to provide it with a return on capital (using the Optimised Depreciated Replacement Cost value of assets multiplied by a weighted average cost of capital) and to recover its estimated operating and maintenance costs: see [19] above. Those elements necessarily included calculation of PNV's taxable income – revenue less estimated operating and maintenance costs and depreciation. 74 An adjustment to the revenue cap was made each year to provide for the expected real rate of improvement in efficiency. As we have seen, the method by which that adjustment was made was "CPI – X", where X was the proxy for the expected real rate of improvement in efficiency: see [19] above. 75 As we know, between the time when the X factor was initially calculated (and the Tariff Order determined in 1995) and the time that PNV was privatised in 1997, the State Government decided to extend the Tariff Order applicable to PNV for a further two years in order to promote price certainty for prospective purchasers of PNV. As a result of changes in the rate of inflation, operational costs and the cost of capital, the level of MAR which the Tariff Order permitted PNV to earn was higher than that required to provide a reasonable return on capital. Consequently, the X factor in the Tariff Order needed to be reset to reflect this change in circumstance. 76 As noted earlier (see [22] above), resetting the X factor would have resulted in lower transmission charges which would have had some unintended – and undesirable – consequences. Those unintended – and undesirable – consequences were a windfall benefit to the owners of the privatised distributors who were charging a fixed retail price for electricity but incurring lower costs (see [22] above) and, in the absence of a change to the Tariff Order, PNV would have derived more revenue (MAR) than it required in order to earn an appropriate return on capital having regard to its expected operating costs: see [23] above. The solution adopted was for the difference between (a) the revenue that would accrue to PNV under the Tariff Order and (b) the MAR that the modelling concluded should have been derived in the period before the Tariff Order lapsed in December 2000, to be recovered from PNV by way of a "special licence fee" that would be separately invoiced and levied by s 163AA of the EIA. These matters were explained to potential bidders in the Information Memorandum: see [23] and [26] above. 77 The question will often arise whether a payment that is calculated by reference to a percentage of profits represents a payment of profits (in the sense of it being a charge on the ultimate fund representing profits), or, instead, remuneration for services rendered, a reward for the use of money, or some other payment laid out for the purpose of earning profits: see, for example, Boulder Perseverance at 229-230. However, such difficulties do not arise in the present case. Here the payments were not ascertained as a percentage of actual profits. Instead they represented amounts to be derived by the licence holder from the provision of the "Prescribed Services" that were over and above all capital and operating costs (including borrowing costs) and after allowing for an appropriate return to shareholders. 78 As is apparent, although the integers in the calculation of the MAR and the licence fee were not disclosed in the express terms of s 163AA, the structure of the imposition of the franchise fee in s 163A and the licence fees under s 163AA was the same – in substance and effect, a share of the profits leaving the holder of the licence with an amount determined to be a reasonable return on the capital of the company deriving that income. The residue, or surplus, was taken by the State as its share of profits. 79 That analysis does not involve characterisation by reference to some other, different transaction. There is no element of "economic equivalence": see City Link Melbourne 141 FCR at 83. As the Full Court said in City Link Melbourne (at 86), Lockhart J's analysis in United Energy was "orthodox analysis": It is not difficult to see on the facts of the case why Lockhart J saw the fee as "akin" to the State taking a share of profits but the conclusion reached by his Honour was not dependent upon there being some joint venture between the State and the distributor. Rather it depended upon the more orthodox analysis that the fee was not a cost of the distributor of deriving its income. The position here is no different. The s 163AA imposts were not a cost of SPI of deriving its income. The s 163AA imposts were payments out of SPI's profits after the calculation of SPI's taxable income. They were not an outgoing incurred in gaining or producing SPI's assessable income or necessarily incurred in carrying on a business for the purpose of gaining or producing such assessable income. 80 The imposts do not satisfy either limb of s 8-1(1). Section 8-1(2) – Loss or outgoing of capital, or of a capital nature 81 It is strictly unnecessary to consider this aspect of the claim. It is, however, appropriate that the following matters be stated. 82 The classic formulation of the matters to be taken into account in determining whether an outgoing is of a capital nature is in the judgment of Dixon J (as he then was) in Sun Newspapers Ltd v Federal Commissioner of Taxation; Associated Newspapers Limited v The Federal Commissioner of Taxation (1938) 61 CLR 337 at 363: There are, I think, three matters to be considered, (a) the character of the advantage sought, and in this its lasting qualities may play a part, (b) the manner in which it is to be used, relied upon or enjoyed, and in this and under the former head recurrence may play its part, and (c) the means adopted to obtain it; that is, by providing a periodical reward or outlay to cover its use or enjoyment for periods commensurate with the payment or by making a final provision or payment so as to secure future use or enjoyment. Of the matters identified by Dixon J, the more critical factor is the character of the advantage sought by the making of the expenditure: GP International Pipe Coaters Pty Ltd v Federal Commissioner of Taxation (1990) 170 CLR 124 at 137. One must ask what the payment was really for and whether what it was for was something that was, in truth and in substance, a capital asset: Colonial Mutual Life Assurance Society Ltd v Federal Commissioner of Taxation (1953) 89 CLR 428 at 454. One looks to what the expenditure was calculated to effect from a practical and business point of view: Hallstroms Pty Ltd v Federal Commissioner of Taxation (1946) 72 CLR 634 at 648; and Federal Commissioner of Taxation v Citylink Melbourne Limited (2006) 228 CLR 1 at [147]-[148]. It is the advantage which the taxpayer seeks and gains from the outgoing that has to be considered in deciding whether the outgoing is of a revenue or of a capital nature: Federal Commissioner of Taxation v South Australian Battery Makers Pty Ltd (1978) 140 CLR 645 at 656 and 662. 83 In the present case, the expenditure (the s 163AA imposts) was involuntary. The s 163AA imposts were tied to, and imposed on, the licence holder, a licence SPI required to conduct its transmission business. However, the s 163AA imposts were not paid to obtain the transmission licence. Indeed, SPI paid a separate and ongoing licence fee for the benefit of holding the licence. That licence fee was imposed on SPI by different provisions of the EIA: see sub-ss 163(3)(a) and (4). 84 What advantage then did the s 163AA imposts secure? SPI submitted that it did not secure any additional advantage (apart from discharging a liability imposed on it) which was not otherwise conferred on it as holder of the transmission licence and, in particular, the s 163AA imposts were not imposed in respect of some statutorily conferred period of exclusivity: cf City Link Melbourne 141 FCR at 90-91 and Star City. 85 Two facts are irrefutable. First, the s 163AA imposts were imposed on SPI, as licence holder, as part of the regulatory framework in which the business was conducted and, secondly, and no less importantly, cl 13.3(d) and recital F of the Asset Sale Agreement recognised that fact and provided that the s 163AA impost payments were to be made as part of the acquisition of the transmission business: see at [29] and [33] above. Those two matters require further elaboration. 86 First, the regulatory framework imposing the s 163AA imposts. It was not concerned with or directed to securing an advantage for SPI. As we have seen, the regulatory framework imposing the s 163AA imposts was directed at regulating the MAR of the holder of the transmission licence. It was not directed to, or paid by, SPI as a mechanism designed to secure freedom from competition. As was the case in United Energy, the s 163AA imposts were imposed following the government review prior to privatisation and were designed to extract excess profits that were to be derived under the Tariff Order. 87 Next, the terms of the Asset Sale Agreement. The s 163AA imposts were not paid to obtain the transmission licence and were not paid as part of the "Purchase Consideration" for the acquisition of the Business. However, the express terms of the Asset Sale Agreement provided that: 1. SPI agreed to buy the Assets on the terms and conditions set out in the agreement: recital B. 2. The total payments to the State by SPI in connection with the privatisation of PNV included the s 163AA imposts (which the State valued in net present value terms at approximately $161,000,000): recital F. 3. A condition precedent to completion was the State procuring the publication of the Licence Fee Order, which included the s 163AA imposts. 4. SPI acknowledged and agreed with the State and PNV that: (1) the amounts to be payable by [ATC] pursuant to the Licence Fee Order are an integral part of the regulatory framework of the industry and [ATC] accepts that it must pay the amounts set out in the Licence Fee Order in order to carry on the Business transferred from [PNV]; (2) [ATC] must not challenge the validity of the Licence Fee Order or the amounts, or the basis of calculating the amounts, specified in the Licence Fee Order; (3) [ATC] agrees to pay to the Treasurer the amounts specified in the Licence Fee Order in accordance with the terms of, and at the times specified in, the Licence Fee Order, whether or not the Licence Fee Order is valid or enforceable; and (4) [ATC] must not transfer the Transmission Licence or allow any person to become a licensee under the Transmission Licence unless the proposed licensee has first delivered to the State a covenant (in form and substance satisfactory to the State) agreeing to be bound by this clause 13.3(d) as if it were the Buyer. 88 As the Licence Fee Order makes clear (see [32] above), the s 163AA imposts were not ongoing and were calculated on a prospective basis with no provision for adjustment. The adjustment made to reflect the timing of the sale (see [35] above) reflected a change to the timing of the payment, not its character. The s 163AA imposts were not made for the purpose of earning the profits of the business. The obligation to make the s 163AA imposts was specifically included in the Asset Sale Agreement as an element of the acquisition of the transmission business, although not part of the Purchase Price. 89 Their connection with, and payment for, the benefits attending the acquisition of the transmission business is further highlighted by: 1. The obligation that the s 163AA imposts be paid to the State of Victoria, not to PNV as the seller of the business; and 2. SPI's own approach to the payments. The liability was taken into account when the bid price was determined. A negotiated reduction in the imposts was capitalised into the purchase price. Similarly, they were recognised in net present value terms in the Asset Sale Agreement. 90 The decision in Tata Hydro-Electric Agencies Ltd, Bombay v Commissioner of Income Tax, Bombay Presidency and Aden [1937] AC 685 is instructive. There, the appellants had acquired an agency business from their predecessors and, as part of that acquisition, agreed to assume an obligation the predecessor had to third parties to pay over a percentage of the fees they earned from a particular client. They subsequently sought to claim the payments to the third parties as a deduction. In finding that the payments were not deductible, the Privy Council said (at 695): [The payments] were certainly not made in the process of earning their profits; they were not payments to creditors for goods supplied or services rendered to the appellants in their business; they did not arise out of any transactions in the conduct of their business. That they had to make those payments no doubt affected the ultimate yield in money to them from their business, but that is not the statutory criterion. They must have taken this liability into account when they agreed to take over the business. In short, the obligation to make these payments was undertaken by the appellants in consideration of their acquisition of the right and opportunity to earn profits, that is, of the right to conduct the business, and not for the purpose of producing profits in the conduct of the business. If the purchaser of a business undertakes to the vendor as one of the terms of the purchase that he will pay a sum annually to a third party, irrespective of whether the business yields any profits or not, it would be difficult to say that the annual payments were made solely for the purpose of earning the profits of the business. (Emphasis added.) 91 As Viscount Cave LC said in British Insulated and Helsby Cables Ltd v Atherton [1926] AC 205 at 213-214: When an expenditure is made, not only once and for all, but with a view to bringing into existence an asset or an advantage for the enduring benefit of a trade, I think that there is very good reason (in the absence of special circumstances leading to an opposite conclusion) for treating such an expenditure as properly attributable not to revenue but to capital. 92 The payments do not, as SPI submitted, take a revenue character because they were imposed on the holder of the licence to transmit electricity. Neither were the payments related to the "process" of derivation of income after privatisation, or as Goldberg J described in Morris & Ors v Federal Commissioner of Taxation (2002) 50 ATR 104 at [79], a "working expense" whereby the occasion of the outgoing is to be found in the income-earning activity itself. In each case, SPI's submissions place an unwarranted level of reliance on the imposts' connection to the transmission licence, particularly having regard to cl 13.3(d) of the Asset Sale Agreement which operated independently of the licence. 93 In light of those factors and considerations, the s 163AA imposts were an outgoing of capital or of a capital nature. 94 As will be apparent, in the present case, the factors leading to that conclusion are different from those which were seen as determinative in United Energy at [193]-[196]. That is not surprising. The regulatory framework and other facts surrounding the nature and timing of the payment were different. 95 Before leaving this issue, reference should be made to the expert evidence adduced by the parties. There was no challenge to the expertise of either expert. Their evidence was directed to the question of the proper accounting treatment of the s 163AA imposts in SPI's statutory accounts. The imposts had been capitalised in SPI's statutory accounts. Those accounts had been signed by SPI's auditors on an unqualified basis. 96 SPI adduced expert evidence from Professor Boymal who expressed the view that the capitalisation of the imposts was contrary to Australian Accounting Standard AASB 1015 and that the imposts should have been expensed when they became due and payable. The evidence adduced by the Commissioner from Mr Parker was generally to the opposite effect. 97 It was not in dispute that the accounting treatment cannot be determinative of the tax outcome and is no substitute for the statutory test in s 8-1: Federal Commissioner of Taxation v James Flood Pty Ltd (1953) 88 CLR 492 at 506-507; Commissioner of Taxation v Citibank Ltd & Ors (1993) 44 FCR 434 at 441; and Citylink Melbourne in the High Court, 228 CLR at 38. 98 As the High Court said in James Flood at 506-507, "[c]ommercial and accountancy practice may assist in ascertaining the true nature and incidence of the item as a step towards determining whether it answers the test laid down" in the statute "but it cannot be substituted for the test". Indeed, as subsequent cases illustrate, accounting evidence may have particular significance in relation to particular issues. For example, the timing of deductions (New Zealand Flax Investments Ltd v Federal Commissioner of Taxation (1938) 61 CLR 179 at 193 and 208; Federal Commissioner of Taxation v Australian Guarantee Corp Ltd (1984) 2 FCR 483 at 492-493; and Coles Myer Finance Ltd v Federal Commissioner of Taxation (1993) 176 CLR 640 at 676) or the meaning of a commercial expression used in an Act (Federal Commissioner of Taxation v Sutton Motors (Chullora) Wholesale Pty Ltd (1985) 157 CLR 277 at 281). 99 What then is the relevance of the accounting evidence in the present case? The accounting treatment in fact adopted is just one fact or matter to be considered. The accounting treatment adopted by SPI in its unqualified statutory accounts supports the conclusion as to the character of the s 163AA imposts arising from the regulatory framework and the Asset Sale Agreement. What then of the expert evidence? Both Professor Boymal's view that the s 163AA imposts should have been expensed and not capitalised and Mr Parker's contrary view that the amounts were correctly capitalised, necessarily considered the issues from an accounting perspective. The facts and matters which support the conclusion that the s 163AA imposts were on capital account for the purposes of s 8-1(2) of the 1997 Act are necessarily different and, further or alternatively, attract different weight and significance. Put another way, the questions that they ask (and must ask) as accountants seeking to apply the relevant accounting standards are not the questions posed by the statute. CONCLUSION 100 The parties are directed to bring in orders to give effect to these reasons for judgment by 4.00pm on 19 September 2013. I certify that the preceding one hundred (100) numbered paragraphs are a true copy of the Reasons for Judgment herein of the Honourable Justice Gordon. Associate: Dated: 12 September 2013